Raise the Debt Ceiling

Raise the Debt Ceiling

Raise the Debt Ceiling, Protect our Communities
Edith Rasell, Minister for Economic Justice

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In the midst of our prolonged economic slowdown, the federal government is borrowing money to pay its bills and meet its obligations. By law, Congress sets the limit on the amount of money the government may borrow. This limit is called the debt ceiling.

The federal government's borrowing limit will be reached on October 17, 2013. On – or  preferably before – this date, the debt ceiling will need to be increased so the government can continue to borrow the money it needs to maintain its operations.

Congress controls the level of debt when it sets the annual federal budget. If the government runs a deficit (that is, spends more than it takes in), then the debt grows and Congress needs to periodically raise the debt ceiling. When the budget is in surplus (revenues exceed spending) the debt falls.

If Congress wants to limit the debt, it must change the budget. It must raise revenue and reduce spending. Raising the debt ceiling, or not, has no impact on either of these. But if the limit is not raised, the United States will go into default with very serious consequences. We must raise the debt ceiling and allow continued borrowing to cover the deficit already authorized by Congress.

Raising the debt ceiling is essentially a bookkeeping task. It does not change federal spending or revenue. It does not affect the budget or change the size of the debt or the deficit. 

The consequences of inaction are dire. According to the U.S. Treasury, failure to raise the debt ceiling would potentially have “catastrophic” consequences. In July, 2011, when Congress was also facing the need to raise the debt ceiling, the chairman of the Federal Reserve Ben Bernanke testified before the Senate Banking Committee that failure to raise the debt ceiling before the deadline would be “calamitous” and “create a severe financial shock.”

If Congress does not raise the debt ceiling in a timely manner, it is impossible to know exactly what would happen since the situation is unprecedented. But two things are likely.

First, with no money the federal government would shut down (or try to continue to function on I.O.U.’s as California did in 2009). Workers – everyone from members of the military to park rangers and air traffic controllers – might not be paid. Creditors would be put on hold. Possibly, payments such as Social Security, veterans’ benefits, and unemployment insurance would not be sent.

Second, the U.S. would default on its debt. It would not pay interest to bond holders and, possibly, would not repay principle when it was due. This could throw financial global markets into chaos and spark a very large spike in interest rates once the U.S. were able to begin borrowing again. Because other categories of debt – for example, some credit cards and mortgages – are linked to the interest paid on Treasury bonds, business and households could also face higher interest payments.

More about what could happen if Congress fails to raise the debt ceiling.

One expert is saying the consequences of default are so severe that President Obama should not allow it to happen; others suggest ways forward if Congress fails to act and propose another course of action for Obama.

What is the government debt and how is it related to the deficit?
Like many households and businesses, the federal government borrows money. Whenever the federal government spends more than it takes in, the budget is in deficit and borrowed money makes up the difference. The government borrows money from individuals, businesses, and other governments by selling Treasury bonds.

The government debt is the total of all the annual deficits and surpluses accumulated over time. In recent decades, the federal government has run a deficit nearly every year, so nearly every year the total debt has grown. The only exceptions were the four years 1998-2001 during President Bill Clinton’s second term of office when the budget was in surplus and the country paid off some of its debt.

Is government debt a bad thing?
As in any business or household, borrowing could be either a good thing or a bad one. It depends on how the money is used. If the money is invested, that is, spent on things that will bring a future financial return that is greater than the cost of the interest payments, then borrowing is good for the country. Examples of investments that can raise future returns above the cost of interest payments include a college education, a new factory, infrastructure to make the economy work better and smarter, and a stimulus to boost economic recovery.

But if the money is spent in ways that do not boost future revenue above the cost of interest, then borrowing is not wise and debt can become a problem. First, interest on the debt must be paid which could drain money from other uses. Second,  large amounts of government borrowing could create a shortage of investment funds for other borrowers. Interest rates would rise and loans would become more expensive for firms and households, limiting their ability to borrow and invest. But if interest rates are low, as they are now, there is no shortage of money available for borrowers. The debt is not causing a shortage of investment funds.

Finally, if the debt becomes so large that investors question whether it can ever be repaid, they might require very high rates of interest to offset their risk, or they might stop lending all together. Our current very low interest rates indicate investors continue to have confidence in the ability of the government to repay its debt.  

Is the U.S. debt too large?
The point at which a country’s debt is “too large” is sometimes difficult to assess but an important indicator is the interest rate. If investors begin to fear that the U.S. might not be able to repay its debt, then interest rates will start to rise. Currently, interest rates on government debt are quite low. Given the high debt levels in many nations that also continue to borrow at low rates, the U.S. probably has nothing to fear for years. Worldwide, U.S. Treasury bonds are regarded as the world’s safest asset – although this could certainly change if the government were to default.

During an economic downturn, deficits are beneficial
During an economic downturn, households and businesses cut back their spending. When customers aren't buying and sales fall, firms respond by cutting back production and laying off workers. As fewer people have jobs and spending continues to decline, sales are also further reduced and firms make more cuts and layoffs. The downward spiral could continue indefinitely. But the federal government can and should intervene. The government must borrow money (run a deficit) and spend it (or give it to people in the form of tax breaks to spend) to stimulate more buying. This will spur firms to want to produce more and they will hire more workers. The newly hired employees with new paychecks will spend more. Firms will want to produce more and will hire additional workers, who will have more to spend. This reverses the downward cycle and creates a beneficial upward spiral. Running a deficit to end a downturn and strengthen the economy is an investment in the future of the country.

The current economic recovery has been very slow, in part, because the deficit-spending boost by the federal government has been inadequate. But as the economy has recovered, the deficit has shrunk from a high of 10% of gross domestic product in 2009 to an estimated 4% in 2013.

The sooner the economy is sound again and people are back to work, the sooner tax revenues will recover. The deficit is an “investment” in a speedier recovery and higher tax revenues in the future. For more on the importance of running a deficit during economic downturns see “The Federal Government Deficit: An Essential Tool for Putting People Back to Work and Ending the Economic Downturn

June 2011, rev.(1): January 2012, rev.(2): February 12, 2013, rev.(3) October 7, 2013

Contact Info

Edith Rasell, Ph.D.
Minister for Economic Justice
700 Prospect Ave.
Cleveland, OH 44115